Inventory carries costs that business owners or managers must consider, including both explicit and implicit costs.
Explicit costs are costs that businesses pay out directly, such as buying and storing inventory, transportation costs to move the inventory, and insurance costs to cover the inventory in case of damage or loss.
Implicit costs are costs that cause economic losses without any out-of-pocket expenses. Examples of implicit costs include lost opportunities because of inventory investments or carrying extra staff or resources to manage the inventory.
A manager’s balancing act is juggling the right level of inventory with the need for profits. Too much inventory risks tying up capital in stock, but too little inventory can mean lost sales when items are out of stock.
Ordering inventory from suppliers is a significant expense for any company, regardless of size. Companies will typically pre-order items in large quantities at a discounted rate, so they can save money on each individual item. The downside, however, is that the company must finance and manage the additional inventory until it is sold.
Storage and warehousing are among the largest costs associated with carrying inventory, as companies must find and maintain a space to store their goods until they are sold, either in their own facilities or through third party warehouses.
Labor costs can also soar if too much inventory is held because of the need to staff extra personnel to manage, record and track the goods. Additionally, inventory can age and become obsolete over time, so stockpiling too much of it can result in costly markdowns as managers try to offload the older goods at a discount.
Insuring the inventory can also add costs. Many businesses require a certain degree of insurance coverage in order to store goods or to protect against product loss or damage due to fire, floods, theft or other malicious acts.
Finally, companies must also consider the financing costs associated with carrying inventory—costs that can quickly add up if the inventory does not turn over quickly. Interest payments and fees for extending financing to suppliers which allow them to build their inventory can also eat away at the bottom line.
In summary, inventory carries costs that must be considered for setting and maintaining a profitable business. Explict costs include the costs associated with buying and storing inventory, managing and shipping it, and insuring it. Implicit costs include lost opportunities and costs associated with advertising and promotions. A manager must balance the need for profits through inventory volume and pricing, while also understanding costs that come with carrying the inventory.
